Friday, February 1, 2008

Microsoft's Discount Rate

Everyone loves the back of the envelope. So, let's make use of it.

Yahoo turned out $205.7m in profits last quarter. So $822.8m a year. Now that means Microsoft is paying $41.7bn. What sort of discount rate rewards this valuation? Well, if it's zero, it's already over fifty years to pay back the investment. Bill Gates (or whoever runs Microsoft) is not buying Yahoo to give the balance sheet a bump in 2060. Trust me on this.

So, what kind of synergies are we expecting from this deal? The Treasury Board of Canada recommends a 10% discount rate for public project evaluation. Let's work with this, even if it's likely an underestimate of Microsoft's discount rate. Microsoft doesn't worry about the rate of time preference. Public policy does.

So, 10%. How far will $2bn in benefits (e.g. $1.177bn in synergies + $0.823bn in profits) go? Well, even if we assume an infinite horizon, the NPV of that stream gets us barely halfway to the price tag. And I'm hesitant to go below 10% discounting. So we're forced to conclude Microsoft thinks Yahoo brings more value. How much?

Well, $3.79bn in synergies, annually. And then we only break even over an infinite period. Raise your hand if you think that Yahoo's assets can produce five billion dollars a year for Microsoft. It's only in that region that the purchase starts looking good.

POSTSCRIPT: Gee, I'm going to feel like a moron if these numbers are wrong. If they are, though unlikely, I blame it on the economics mixer this evening. Drinking and discounting don't mix.

NOTE: Apologies if a degenerate copy of this post ended up in your RSS aggregator. Accidentally posted.